DEMAND

Two important forces of market are Demand & Supply Demand Can be defined as the desire for a good for whose fulfillment, a person has sufficient resources & willingness to buy the good. Desire without money income, is a mere desire Potential demand - Desire with resources but without willingness to spend Effective demand - Desire accompanied by ability & willingness to pay Individual Demand Quantity of a commodity that a person is willing buy at a given price over a specified period of time, say per day, per week, per month etc. Market Demand Total quantity that all the users of a commodity are prepared to buy at a given price over a specified period of time. Market demand is the sum of individual demand Law of Demand All other things remaining constant, the quantity demanded of a commodity increases when its price decreases & decreases when its price increases Other things - Consumers income - Price of related goods - Consumers taste & preferences - Advertisement

Demand Curve Graphical representation of Law of demand. Demand curve concentrates on the price quantity relationship Q = f(P)

Why Demand curve slopes downward to the right OR Reasons underlying the Law of demand 1. Income effect Price of a commodity falls, real income of its consumers increases in terms of this commodity - they are required to pay less for the same quantity - demand for the commodity increases - increase in demand on account of increase in real income is known as income effect - income effect is negative in case of inferior goods - when price of an inferior good falls, consumers real income increases - they substitute the superior goods for inferior goods
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2. Substitution effect - When price of a commodity falls, it becomes relatively cheaper compared to its substitutes, if their prices remain constant - Consumers substitute cheaper goods for costlier ones - Therefore demand for the cheaper commodity increases 3. A commodity tends to be put to more uses or less urgent uses when it becomes cheaper. eg: water Chief characteristics of Law of Demand 1. Inverse relationship The relationship between the price & qty demanded in inverse. ie., if the price rises, demand falls, & if the price falls, demand goes up. 2. Price is an independent variable & demand a dependent variable Under law of demand, it is the effect of price on demand and not the effect of demand on price. 3. Other things remain the same There should be no change in other factors influencing demand, except price. If the other factors, say income, substitutes price, consumers taste & preference, advertisement, etc vary, the demand may change. Exceptions to Law of Demand 1. Expectations regarding future prices When consumers expect a continuous increase in the price of a durable commodity, they buy more of it, despite increase in its price. Eg. Shares Similarly when consumers anticipate a considerable decrease in future, they postpone their purchase & wait for the price to fall to the expected level.
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2. Prestigious goods The Law does not apply to the commodities which serve as status symbol. Eg. Gold, antiques Rich people buy such goods mainly because their prices are high. 3. Giffon goods Giffon goods may be any commodity much cheaper than its substitutes, consumed mostly by the poor households Eg. Poor people spent a major part of their income on wheat & meat. When price of wheat rises, they reduce the consumption of meat & increase the consumption wheat because wheat is still cheapest. Thus rise in price of wheat led to increased sales of wheat. LAW OF DIMINISHING MARGINAL UTILITY Law states that as the quantity consumed of a commodity increases, over a unit of time, the utility derived by the consumer from the successive units goes on decreasing, provided the consumption of all other goods remains constant. Units 1 2 3 4 5 6 7 8 Total Utility 20 38 53 64 70 70 62 46 Marginal Utility 20 18 15 11 6 0 -8 -16

Extra satisfaction that he gets by the consumption of each successive toast goes on decreasing till it goes down to zero at 6th , & then it becomes ve.

Total utility of a qty of a commodity is maximum when the marginal utility is zero. Assumptions (Limitations) 1. The unit of the consumer goods must be standard eg: a cup of tea, a bread 2. Consumers taste & preference must remain the same during the period of consumption. 3. There must be continuity in consumption 4. The mental condition of the consumer remains normal during the period of consumption Law of diminishing marginal utility Graphical illustration TOTAL UTILITY CURVE

MARGINAL UTILITY CURVE

0 1 2 3 4 5 20 18 15 11 6

Indifference curves An indifference curve is the locus of points, each representing a different combination of two goods, which yield the same utility or level of satisfaction to the consumer so that he is indifferent between any two combinations of goods when it comes to making a choice between them. It may not be possible for him to tell how much utility he gets from a particular combination, but it is possible for him to tell which of the two combinations give him - equal satisfaction. - And more or less satisfaction Indifference schedule Combination Apples 1 15 2 11 3 8 4 6 5 5 INDIFFERENCE CURVE Mangoes 1 2 3 4 5

IC Map We can draw similar indifference curves showing combinations of apples and mangoes which represent greater or lesser satisfaction. A set of indifference curves is called an indifference map. Properties of Indifference curves 1. ICs have a negative slope 2. ICs are convex to the origin 3. ICs do not intersect 4. Upper IC indicate a higher level of satisfaction than the lower ones. 1. ICs have a ve slope - ve slope implies that a) two commodities can be substituted for each other b) if quantity of one commodity decreases, qty of the other commodity must increase, if the consumer has to stay at the same level of satisfaction. 2. ICs are convex to origin - two commodities are substitutes for one another - the marginal rate of substitution between the two goods decreases as a consumer moves along an indifference curve. - Two commodities are not perfect substitutes for each other - MU of a commodity increases as its quantity decreases

3. ICs do not intersect

At A Consumer is on IC 1 At B Consumer is on IC 2 B gives him higher level of satisfaction than A. C lies on both ICs ie. Equal to A&B which represent different levels of satisfaction. One level can not be equal to two different levels satisfaction. Therefore ICs can not cut each other. 4. Upper ICs represent a higher level of satisfaction than the lower ones. - Upper IC contains a larger qty of one or both the goods than the lower IC - A larger qty of a commodity is supposed to yield a greater satisfaction than the smaller qty.

Consumers equilibrium The consumer is said to be in equilibrium when he obtains the maximum possible satisfaction from his purchases, given the prices in the market and the amount of money he has for making purchases. Equilibrium with indifference curves Assumptions 1. Consumer has an indifference map showing his preferences for various combinations of the two goods. This preference remains the same throughout the analysis. 2. He has constant amount of money to spend. If he does not spend it on one good, he must spend it on the other. 3. Prices of the goods in the market are constant 4. each of the goods is homogeneous 5. Consumer tries to maximize his satisfaction.

Price income line is AM. Consumer has to spend on apples and mangoes. Equilibrium must be on some point on this line. The consumer will be in equilibrium at the point P. ie. He will be buying OR mangoes and OH apples. The consumer will maximize his satisfaction & be in equilibrium at a point where the price line touches (or is tangent to) an indifference curve. Point P lies on IC2. This is the highest IC he can go given the money he has & the prices of the goods in the market. Any points other than P on the given price line give less satisfaction. At S hell be on IC1 & will be getting less satisfaction than P which lies on a higher IC2 Similarly at point K also the consumer will not be in equilibrium because it lies on IC1 lower than IC2. Conditions of equilibrium 1. The price line should be tangent to an IC 2. At the point of equilibrium, an IC must be convex to the origin.

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ELASTICITY OF DEMAND - is a measure of the relative change in amount purchased in response to a relative change on price in a given demand curve. - Degree of responsiveness of qty demanded to a change in price A small change in price may lead to a great change in demand. In that case the demand is elastic If a big change in price is followed by a small change in demand , it is said to be inelastic demand Eg. Salt 1. Perfectly elastic or infinite elasticity

Even a very very small reduction in price leads to an unlimited extension of demand.

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2. Perfectly inelastic or zero elasticity

Price may fall or rise, the amount demanded remains the same. Above two cases are only theoretical. In real life, elasticity of demand will be between zero & infinity. 3. Highly elastic demand Where a reduction in price leads to more than proportionate change in demand.

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4. Highly inelastic demand Where a reduction in price leads to less than proportionate change in demand

5. Unit elasticity Proportionate change in price causes equal proportionate change in the qty demanded.

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Types of elasticity 1. Price elasticity - is the ratio of a relative change in qty to a relative change in price E= Relative change in qty Relative change in price E= Proportionate change in the qty demanded Proportionate change in price Ep= Delta q Delta p Ep = Price elasticity q=qty p= price delta = small change Factors determining price elasticity of demand 1. Nature of the commodity The demand for necessary articles is inelastic Eg: salt, rice Consumption does not change much with change in price The demand for luxuries changes much due to price change. Here the demand is elastic. Eg: silk sarees, T.V. 2. Extent of use A commodity having a variety of uses has elastic demand Eg: Steel can be used for many purposes. A commodity having limited use has inelastic demand xp q

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3. Range of substitutes A commodity having a no. of substitutes has elastic demand, because if its price rises, its consumption can be reduced in favour of the substitutes. Eg: if bus fare rises, people will use trains A commodity without substitutes has inelastic demand 4. Income level People with high income are less affected by price changes. A rich man will not reduce the consumption of fruits or milk evenif their price rises significantly. But a poor man can not do so. Hence the demand for fruits or milk is inelastic for the rich, but elastic for the poor. 5. Proportion of the income spent on the commodity Where an individual spends only a small part of his income on the commodity, the price change does not affect his demand for the commodity. Eg: Matchbox, salt.. the demand is inelastic. 6. Urgency of demand A person would consider things essential depending upon 2 factors 1. the availability of substitutes 2. habit If there is a substitute of a commodity, its demand will be elastic. For a person, with smoking habits, demand for cigarettes become inelastic. Urgency of demand tends to cause inelastic demand 7. Durability of a commodity In case the commodity is durable or repairable, if the price rises considerably, one is likely to use the commodity for a long time. Demand decreases. Hence higher is its elasticity Eg: TV
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8. Purchase frequency of a product If the purchase frequency of a product is very high, its demand is likely to be more price elastic. INCOME ELASTICITY - is a measure of responsiveness of potential buyers to change in income. - is the ratio of the percentage change in the amount spent on the commodity to a percentage change in the consumers income, price of commodity remaining constant Income elasticity = Proportionate change in the qty purchased , Proportionate change in income While prices remaining constant

Types of Income elasticity 1. Zero income elasticity A change in income will have no effect on the quantities demanded. Eg: salt 2. Negative income elasticity An increase in income may lead to a reduction in the quantities demanded. Such goods are called inferior goods. Eg: from beedies to cigarettes 3. Positive income elasticity An increase in income may lead to an increase in the quantities demanded. Such goods are called superior goods
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Positive income elasticity can be of 3 kinds A. Unity elasticity - when an increase in income leads to proportionate change in the quantities demanded B. More than unity elasticity - when an Increase in income leads to more than proportionate change in quantities demanded eg: luxuries C. Less than unity elasticity - when the increase in income leads to a less than proportionate change in the quantities demanded. Eg: necessary articles, wheat, rice CROSS ELASTICITY A change in the price of one good causes a change in the demand for another. Cross elasticity of Demand for X & Y = Proportionate change in purchase of commodity X ____________________________ Proportionate change in the price of Commodity Y This type of elasticity arises in the case of inter- related goods such as substitutes and complimentary goods. Substitutes The increase in demand of one good will decrease the demand in the other. Complimentary goods The increase in demand of one commodity will result in increase in demand of the complimentary commodity. Eg: Cars & Tyres

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CHANGE DEMAND - means an increase in demand or a decrease in demand - An increase in demand means that at the same prices as before, increased quantities are demanded

An increase in demand is represented graphically by a new demand curve, lying to the right of original demand curve. The increase in demand may be due to a rise in peoples income, a rise in the price of substitute, a fall in the price of compliment, improvements in the product, peoples taste & discovery of a new use for the product etc. Decrease in demand means that at same prices, lower quantities are demanded. Graphically, the decrease in demand would be shown by a curve lying to the left of the original curve.

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Decrease in demand may be due to a fall in peoples income, a fall in the price of the substitute, a rise in the price of the compliment, an adverse change in taste etc. Eg: An increase in the price of petrol, has led to a decline in the demand for cars. An increase or decrease in demand is also known as shift in demand. Change in demand & Elasticity of demand Change in demand occurs when price does not change but demand changes due to other factors, like income, taste etc. Elasticity of demand refers to that change in demand which occurs due to change in price, when other factors remaining the same. Change in price results in movement along the demand curve, where as changes in other factors result in shifts of the entire curve. Measurement of Elasticity 3 Methods 1. Total outlay method According to this method, we compare the total outlay of the purchases (Total revenue of the seller) before & after the variations in price. Elasticity of demand is expressed in 3 ways. 1. Unity Unity elasticity - means, even though the price has changed, the amount spent remains the same. The rise in price is exactly balanced by reduction in purchases and vice versa.
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2. Greater than Unity

3. Less than unity

- A rectangular hyperbola represents unity elasticity Greater than Unity Elasticity - with the fall in price, the total amount spent increases, or with a rise in price, total amount spent decreases Less than Unity elasticity - when the total amount spent increases with a rise in price and decreases with a fall in price. Price of pen (a) 1) 2) 3) 4) 5) 6) 8 7 6 5 4 3 Qty demanded (b) 3 4 5 6 7 8 Total outlay (c)=(a)x(b) 24 28 30 30 28 24

Between (1) &(2) and (2)& (3) Elasticity is greater than unity, because the total amount spent decreases, when the price rises & increases when the price falls Between (3) & (4) it is unity as the total amount spent remains the same even though the price has changed. Between (4) & (5) and (5) & (6) the elasticity is less than unity because the total amount spent increases when the price rises & decreases with a fall in price.

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2. Proportional Method In this method, we compare the % change in demand Price elasticity = proportionate change in amount demanded Proportionate change in price = change in demand / amount demanded change in price price

eg: price of x falls from Rs.500 to 400. As a result of this fall in price, the demand for x has gone up from 400 to 600. Elasticity of demand = 200 400 / 100 500

= 2/4x5/1= 5/2 = 2.5% ====== The elasticity of demand is always negative, because change in qty demanded is in opposite direction to the change in price. 3. Geographical method 1. Point Elasticity This method tells up how to measure elasticity of demand at any point on a demand curve.

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DD is a straight line demand curve. Elasticity = Distance from D to a point on the curve The distance from the other end to that point The elasticity of demand on the points P1,P2 & P3 respectively is DP1 DP1 DP2 = 1 DP2 ie. Elasticity is unity Elasticity at a lower point on the curve is less than unity than at a higher point. For a demand curve, which is not a straight line, tangent have to be drawn at the point on the curve where elasticity is to be measured. , DP2 DP2 & DP3 DP3

Since P2 is in the middle of the curve

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DD is the demand curve. Two tangents PM & PM are drawn respectively at the points T & T. At the point T, elasticity will be equal to TM. At the point T elasticity is MT. Elasticity at T is greater than elasticity at T. 2. Arc Elasticity In arc elasticity, we express the price change as proportion of the average of the initial price & change in price. Similarly, we express the change in the quantity demanded as a proportional of the average of the initial & the changed quantity. Thus the arc elasticity is the average elasticity.

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On any two points of a demand curve, the price elasticities of demand are likely to be different. Suppose at P, 6 units of a commodity are demanded at Rs.3, and at point M, 8 units at Rs. 2. If we move from P to M, Ep = q/q p/p = 2/6 / 1/3 = 2/6 x 3/1 = 1 If we move from M to P, Ep = 2/8 / 1/2 = 2/8 x 2/1 = 1/2 Thus the point method of measuring elasticity at two points on a demand gives different elasticity coefficients. To avoid this discrepancy, an average of the two values is calculated on the basis of the formula. q1 q2 / q1 q2 p1- p2 p1+p2

Where q1 & q2 are the two quantities at the two prices p1& p2 respectively. Applying the above values of quantities and prices, we get, 6-8 / 6+8 3-2 =-2 x5 3+2 14 1 =-5 7

This result is more satisfactory. The arc method may be put in simple language as under Difference in q / difference in P Sum of q sum of P DEMAND DISTINCTIONS 1. Producers goods & Consumers goods Producers goods are those which are used for the production of other goods either consumer goods or producer goods themselves.
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Eg: machines, tools Consumer goods can be defined as those which are used for final consumption. Eg : readymade dresses, prepaid food.

2. Durable & non durable goods Durable goods are those which can be used for a period of time. Eg: car, fridge Non durable goods are those which cannot be consumed more than once. Eg: bread, milk 3. Derived demand & Autonomous demand When demand for a product is tied to the purchase some parent product, its demand is called derived. Eg: demand for all producers goods, namely raw materials, components etc. If the demand for a product is independent of demand for other goods, it is called autonomous demand. 4. Industry demand & company demand Industry demand is the total demand for the products of a particular industry. Eg: Total demand for steel in the country Company demand is the demand for the products of a particular company Eg: demand for steel produced by TISCO. The company demand may also be expressed as % of the industry demand. The % so arrived at would denote the companys market share for the product. 5. Short run demand & long run demand Short run demand refers to the demand with its immediate reaction to price changes, income fluctuations etc.
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Long run demand is that which will ultimately exist as a result of the changes in pricing, promotion or product improvement etc.

DEMAND FORECASTING Demand forecasting denotes an estimation of the level of demand of the product at a future period under given circumstances Factors involved in demand forecasting 1. Time period Short run forecasting - up to one year - provides information for tactical decisions - it is concerned with day to- day operations Long run forecasting - up to 20 years - provides information for major strategic decisions - planning for new units & expanding the existing units 2. Demand forecasting may be undertaken at three different levels a) Macro level concerned with business conditions over the whole economy - to make the basic assumptions on which the business must base its forecasts. b) Industry level prepared by different trade associations c) Firm level - from the managerial view point 3. General or specific forecasting General for all the products Specific for a specific product 4. New product or established product
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5. Producer goods or consumer goods 6. Competition, Political developments Methods of forecasting 1. Survey of buyers intentions ( opinion survey) - is a direct method of estimating demand in the short run is to ask customers what they are planning to buy for the forthcoming time period usually a year. Disadvantages a. Biases ie. If shortages are expected, customers may tend to exaggerate their requirements b. Not useful in the case of household customers as there is an irregularity in buying intentions c. Customers are numerous and hence this method is impracticable & costly. 2. Delphi method - questioning a group of experts repeatedly until the issues causing disagreement are clearly defined. - Participants supply their responses to the coordinator. He provides each expert the responses of others including their reasons. - Each expert is given opportunity to react to the information advanced by others. This interchange is anonymous advantages 1. Maintenance of anonymity of respondents 2. Getting responses from experts at one time 3. Time & money saving Conditions A) Panelists must be experts possessing knowledge b) Conductors should possess ample abilities to conceptualize the problems for discussion & generate ideas.
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3. Collective opinion ( sales force polling) salesmen are required to estimate expected sales in their respective territories. salesmen are closest to customers & they know the customers reaction to the products. Individual estimates are consolidated to find out the total estimated sales. This is further examined in the light of factors like proposed changes in selling prices, product designs, advertisements, competition etc. This method takes the advantage of the collective wisdom of salesmen, top mgrs, economists etc. Advantages 1. Simple & does not involve the use of statistical techniques 2. Based on the knowledge of salesmen directly connected with sales. Disadvantages a. personal opinions can influence the forecast. Salesmen may understate the forecast if their sales quotas are to be based on it. b. Useful in short-term forecasting c. Sales men may be unaware of the broader economic changes. 4. Analysis of Time series & Trend projections When data on sales relating to different time periods are arranged in an order, it is called time series. This represented the past pattern of effective demand for a particular product. The trend line is projected into future by extrapolation. The basic assumption is that past rate of change of the variable understudy will continue in the future. Whenever a turning point occurs, the trend projection breaks down. At turning points, management will have to revise its sales & production strategies.

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There are four sets of factors responsible for the characterization of time series. 1. trend 2. seasonal variations 3. cyclical fluctuations 4. irregular forces Original time series data Advantages 1. simple & inexpensive Trend analysis This method of estimating and fitting trend line by observation is easy and quick. It involves the plotting of annual sales on a graph and then estimating just by observation where the trend line lies. The line can then be simply extended to a future period and corresponding sales forecast read against that years. This method lacks accuracy hence a time series analysis using least squares equation is used Time series analysis using Least Squares method The method of least squares used straight line equation. Sales = a + b (year number) S = a + b. T Where a and b are the constants representing the intercept and slope respectively of the estimated straight line. In order to determine the values of a and b, the following 2 normal equations are used. S = Na + b T ST = a T + b T2 (O) (T) (S) (C) (I) - general tendency - change in climate - booms & depressions - famines, floods

=TxSxCxI

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Q1. The following data referred to sales in 1000s of rupees, of a certain product during 5 years. Year 1993 1994 1995 1996 1997 be doubled. Answer Year 1993 1994 1995 1996 1997 N=5 S 605 715 830 790 835 T 1 2 3 4 5 T2 1 4 9 16 25 T2 = 55 S.T 605 1430 2490 3160 4175 S.T = 11860 sales 605 715 830 790 835

Assuming the present trend continues, in which year will you expect 1994 sales to

S = 3775 T= 15 S=Na+b T ST = a T + b T2

3775 = 5 x a + 15 b ---------------------------( 1) 11860 = 15 a + 55 b---------------------------(2) ( 1 ) x 3 gives 11325 = 15 a + 45 b-----------------( 3 )

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( 2 ) - ( 3 ) gives 11860 = 15 a + 55b minus 11325 = 15 a + 45 b 535 = 10b b = 53.5 11325 =15 a + 45 x 53.5 11325 2407.5 = 15 a a = 594.5 S = a + b. T S = 594.5 + 53.5 T So the Trend equation is S = 594.5 + 53.5 T Given the value of S for 1994 is 715. Its double value is 1430. To find the year in which sales equals to 1430, we substitute the value as 1430 = 594.5 + 53.5 T 835.5 = 53.5 T T = 16 There fore the year in which the sales to be doubled is 2008. =============================================== Q.2 The annual sales of a company Year 1968 1969 1970 1971 1972 sales (1000s) 45 56 78 46 75

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By the method of least squares find the value for each of the 5 years. Also calculate the annual sales of 1973. Answer Year 1968 1969 1970 1971 1972 N=5 sales 45 56 78 46 75 S= 300 T 1 2 3 4 5 T = 15 T2 1 4 9 16 25 T2 = 55 S.T 45 112 234 184 375

S.T= 950

S = Na + b. T S.T = a T + b T2 300 = 5 a + 15 b----------------------( 1 ) 950 = 15 a + 55 b ---------------------( 2 ) (1) x 3 gives (2 ) - ( 3 ) gives 950 = 15 a +55 b minus 900 = 15 a + 45 b 50 = 10 b b=5 300 = 5a + 75 a = 45 S=a+bT S = 45 + 5 T 900 = 15a + 45 b--------------(3)

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Trend values for various years S (1968) S (1969) S (1970) S (1971) S (1972) S (1973) Q3 Year 1998 1999 2000 2001 2002 N=5 production T 40 45 46 42 47 1 2 3 4 5 T2 1 4 9 16 25 T2= 55 P.T 40 90 138 168 235 P.T=671 = 45 + 5 x 1 = 50------- Rs. 50,000 = 45 + 5 x2 = 55---------Rs. 55,000 = 45 + 5 x 3 = 60----------Rs. 60,000 = 45 + 5 x 4 = 65-----------Rs. 65,000 = 45 + 5 x 5 = 70 -------------Rs. 70,000 = 45 + 5 x 6 = 75---------------Rs.75,000

P = 220 T = 15

1. Fit a the straight line to these frequencies. 2. Predict the production for the years 2003 & 2004 P = Na + b T P T = a T + b T2 220 = 5a + 15 b----------------(1) 671 = 15 a + 55 b----------------(2) (1) x 3 gives 660 = 15a + 45 b---------(3)

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( 2) (3) gives 671 = 15 a + 55 b minus 660 = 15 a + 45 b 11 = 10 b b = 1.1 220 = 5a + 16.5 5a = 203.5 a = 40.7 P = 40.7 + 1.1 T Trend values P 2003 P 2004 = 40.7 + 1.1x 6 = 40.7 + 1.1 x7 = 47.3--------------47300units = 48.4---------------48400 units

====================================================== 5. Use of Economic Indicators This approach based on certain economic indicators 1) personal income for demand of consumer goods 2) Agricultural income for the demand of fertilizers 3) Automobile registration for the demand of car accessories, petrol etc. Limitations 1. finding an appropriate economic indicator may be difficult 2. for new products, no past data exist.

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